chapter 2 money management strategy: financial statements and budgeting 2-1 kapoor dlabay hughes...

Chapter 2

Money Management

Strategy: Financial

Statements and Budgeting

2-1

Kapoor Dlabay Hughes Ahmad

Prepared by Cyndi Hornby, Fanshawe College 2006 McGraw-Hill Ryerson Ltd.

2006 McGraw-Hill Ryerson Ltd.

Learning Objectives – Chapter 2

1. Recognize relationships among financial documents and money management activities

2. Create a system for maintaining personal financial records

3. Develop a personal balance sheet and cash flow statement

4. Create and implement a budget5. Calculate savings needed to achieve

financial goals

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Learning Objective # 1Recognize relationships

among financial documents and money management activities.

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Opportunity Cost & Money Management

Spending money reduces the amount you can save and investSaving and investing reduces the amount you can spend nowBuying on credit ties up future incomeUsing savings for purchases results in lost interest -savings can’t be used for other purposes

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Opportunity Cost & Money Management

Every decision made means you give up something elseComparison shopping can save money but takes your valuable time

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Major Money Management Activities

Createand

implementa plan forspending

(budgeting)and

saving.

Createpersonalfinancial

statementsof income

andoutflow(balance

sheet andcash flow).

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Storeand

maintainpersonalfinancialrecords

anddocuments.


Learning Objective # 2Create a system for

maintaining personal financial records

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Why Keep Financial Records?

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Handling daily business affairs, including paying of bills on timePlanning and measuring financial progressCompleting required tax formsMaking effective investing decisionsDetermining available resources for current and future buying


What to Keep in Your Home File

Items you refer to oftenPersonal and employment recordsTax recordsFinancial services recordsMoney management recordsCredit records

Consumer purchase recordsInsurance recordsInvestment recordsHousing and car recordsEstate planning and retirement records

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What to Keep in a Safe Deposit Box

Safe deposit box is for records and items that would be hard to replace

Birth, marriage and death certificatesCitizenship and military papersAdoption and custody papersSerial numbers and photos of valuablesGIC’s and bank account numbersMortgage papers and titlesList of insurance policy numbersStock and bond certificatesCoins and collectiblesCopy of will

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Other Places to Keep Records

AutomobileVehicle registration

LawyerOriginal of your will and living will

Doctor and hospitalCopy of your living will

Home computerCurrent and past budgetsChequing account recordsWills, estate plans, investmentsPast income tax returns

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Learning Objective # 3Develop a personal balance

sheet and cash flow statement

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Purpose of Personal Financial Statements Summarize the value of the items you

own and the amounts that you owe Track your cash inflows by source and

your outflows by type Identify strengths and weaknesses in

your current financial situation Measure progress towards your

financial goals Provide data for use in filing your

income tax return or applying for credit

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Balance Sheet A financial statement that reports

what an individual or family owns or owes; also called a net worth statement

- =

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Items of value(what you own)

Amounts Owed(what you owe)

Net Worth(your wealth)


The main categories of assets are usually listed first, and typically in order of liquidityAssets are followed by the liabilities


Components of a Balance Sheet(Net Worth Statement)

Assets - what you ownLiquid assetsReal estatePersonal possessionsInvestment assets

Liabilities - what you oweCurrent liabilitiesLong term liabilities

Net Worth.Assets minus liabilitiesInsolvent means liabilities far exceed assets

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Assets = liabilities + owner's equityLooking at the equation in this way shows how assets were financed

Borrowing money (liability)Using the owner's money (owner's equity)

Balance sheets are usually presented with assets in one section and liabilities and net worth in the other section with the two sections balance out


Types of Balance SheetA balance sheet summarizes an organization or individual's assets, equity and liabilities at a specific point in time (month/ year) Individuals and small businesses tend to have simple balance sheetsLarger businesses tend to have more complex balance sheets, and these are presented in the organization's annual reportA balance sheet is often presented alongside one for a different point in time (typically the previous year) for comparison


Personal Balance Sheet

Current assets such as cash in checking accounts and saving accountsLong-term assets such as common stock and real estateCurrent liabilities such as loan debt and mortgage debt due, or overdueLong-term liabilities such as mortgage and other loan debt


US Small Business Balance Sheet

A small business balance sheet listsCurrent assets such as cash, accounts receivableInventory, fixed assets such as land, buildings, and equipmentIntangible assets such as patents, and liabilities such as accounts payable, accrued expenses, and long-term debtContingent liabilities such as warranties are noted in the footnotes to the balance sheet


Statement of cash flows or funds flow statementA financial statement that summarizes cash receipts and payments for a given period of time

+ + =

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Cash Flow Statement

Total cash received during that time

period

Cash outflows during the time

period

Cash surplus or

deficit


Cash Flow StatementShows how changes in balance sheet accounts and income affect cash and cash equivalentsBreaks the analysis down to operating, investing, and financing activitiesEssentially, the cash flow statement is concerned with the flow of cash in and cash out


Why cash flow statement is important?

Help to get a clear picture of financial healthCash surplus or deficit• Cash surplus (positive balance): build

wealth• Cash deficit: destroy wealth


If your cash flow statement is positive, then you have some additional cash each month that you can use to help you reach your financial goals

Build emergency fund, pay down debt, invest, etc.

If your cash flow statement is negative, then it is time to look for ways to makes changes

Look for areas you can trim back on expenses, and ways to increase income


Components of a Cash Flow Statement

Shows inflow and outflow during a given time period.

Record income.•Income from employment.•Savings and investment income.•Other sources.

Record cash outflows.•Fixed and variable expenses.

Net cash flow can be a surplus or a deficit.

Used as a basis for creating a spending, saving and investment plan.

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Analyzing Your Current Financial Situation

Measure your progress toward your financial goals

Save and invest on a regular basisIdentify how your assets are distributed among the different categories

Each asset has its purposeCalculate your current asset allocation

Allocation of financial assets between cash, fixed income and equity investments

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Identify whether your investments are tax efficient

Provide you with highest after-tax returnIdentify assets that may be lost, stolen, damaged or destroyed

May require insurance coverageSummarize the types and extent of your indebtedness

Borrowed to finance depreciating or appreciating assetsMany credit cards may inflate your debt ratio

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Compiling your latest cash flow statements will

Highlight your sources of incomeReveal whether you are overspendingHelp assess your spending and saving patterns

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Learning Objective # 4Create and implement a

budget.

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Creating and Implementing a Budget

Budget: A specific plan for spending incomePurpose:

Live within your budgetSpend your money wiselyPrioritize and attain your financial goalsPrepare for financial emergenciesDevelop wise financial management habits

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The Budgeting ProcessStep 1: Setting Financial Goals

Plans for future activities that require you to plan your spending and investingShould be realistic; stated in specific, measurable terms; have a definite time frame; imply type of action to be taken

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The Budgeting ProcessStep 2: Estimating Income

Estimate available money for given period of time – usually one monthBased on number of times income received each month, spending should be planned accordinglyDifficult if your earnings vary by season or income is irregular

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The Budgeting ProcessStep 3: Budgeting Emergency Fund

and SavingsRecommend 3-6 months of living expenses be established

Step 4: Budgeting Fixed ExpensesWill depend on your current needs and plans for the future

Step 5: Budgeting Variable ExpensesWill fluctuate by household situation, time of year, health, economic conditions, etc.

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The Budgeting ProcessStep 6: Recording Spending

AmountsRecord actual income and expensesBudget Variance – difference between amount budgeted & the actual amount received or spentDeficit – actual spending exceeds planned spendingSurplus – actual spending less than planned spending

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The Budgeting ProcessStep 7: Reviewing Spending and

Saving PatternsReview your financial progressRevise your goals and budget allocations

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Successful Budgets Are...Well plannedRealisticFlexibleClearly communicated

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Learning Objective # 5Calculate savings needed to

achieve financial goals.

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Saving to Achieve Financial Goals

Common reasoning for saving include…To set aside money for irregular and unexpected expenses.To pay for the replacement of expensive items, such as appliances, cars or a down payment on a house.Save to buy special items or pay for a vacation.Put aside money to long-term expenses such as retirement or children's education.To earn income from the interest on savings for use in paying living expenses.

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Selecting a Saving Technique

Should make regular periodic savings deposits Can be a percentage of income (5-10%) or specific dollar amount

Write a cheque each payday and deposit into a special savings account at another financial institutionPayroll deductionDirect depositSaving coins at end of each day

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Suggestions for Dual-Income Households

Pooled Income – incomes combined and bills paid from poolSharing the Bills – each responsible for predetermined bills50/50 – each contribute equally to poolProportionate Contribution – each contribute percentage of his/her income 2-28


Summary of Learning ObjectivesRecognize relationships among financial documents and money management activities• Requires effective coordination of personal

financial records, personal financial statements and budgeting activities

Create a system for maintaining personal financial records• Foundation of effective money management• Should provide easy access as well as

security

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Summary of Learning ObjectivesDevelop a personal balance sheet and cash flow statement• Net worth statement lists all items of

value (assets) and all amounts owed to others (liabilities)

• Difference is your net worth• Person income and expenditures

statement is a summary of cash receipts and payments for a given period of time

• Provides data on your income and spending patterns

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Summary of Learning ObjectivesCreate and implement a budget• Seven-step process will help you live

within your means and channel your resources toward the attainment of prioritized financial goals

Calculate savings needed to achieve financial goals• Future and present value calculations may

be used to compute the increased value of savings for achieving financial goals

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chapter 2 money management strategy: financial statements and budgeting 2-1 kapoor dlabay hughes...

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